The former African Player of the Year had been locked in talks over a move to the Reebok Stadium for over a week but has finally put pen to paper on a deal which will see him remain at the club until the summer of 2005.
Diouf joined Liverpool from Lens for over £10 million two years ago having caught the eye of the Anfield scouts whilst playing for his country in the 2002 World Cup in Japan and Korea.
However the 23-year old was unable to transform his international displays to club level and this resulted in him scoring just six times during his spell on Merseyside including a goal against the Wanderers in a Premiership match 18 months ago.
Wanderers boss Sam Allardyce was looking for an attacker with pace having missed out on both Henri Camara and Dwight Yorke so the signing of the African has ended a long search. Diouf's versitility could prove an excellent foil for the likes of Kevin Davies and Les Ferdinand in the season ahead as Allardyce looks to rejuvanate yet another career which has gone slightly off the rails in recent times.
Diouf will travel with the rest of the Wanderers squad for Saturday's trip to Fulham although it is expected that he will have to watch from the stands whilst he settles into his new environment.
"You know what it's like with the financial side of football, and you always have to sort out the financial side first," Allardyce told Sky Sports News.
"Gladly the chairman and Rick Parry have come to agreement which we are very pleased about.
"Now we can maybe see about rekindling El Hadji's career and stand Liverpool in good stead as far as his value. I don't think he'll be involved at the weekend, but he will travel down and get to know all the players and all the different nationalities. It's very important to integrate quickly.
"His past record doesn't suggest that [he will get 20 goals a season] but I think his qualities suit The Premiership, and our system. His pace is a threat and maybe a few more goals will come his way."